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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
(MARK ONE)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                      TO
COMMISSION FILE NUMBER: 000-19807
 
 
 
synopsyslogoa07a01a10.jpg
SYNOPSYS, INC.
(Exact name of registrant as specified in its charter)
 
 
 
DELAWARE
 
56-1546236
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
690 EAST MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043
(Address of principal executive offices, including zip code)
(650) 584-5000
(Registrant’s telephone number, including area code)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
ý
  
Accelerated Filer
 
¨
 
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of August 15, 2017, there were 150,247,663 shares of the registrant’s common stock outstanding.



Table of Contents

SYNOPSYS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED JULY 31, 2017
TABLE OF CONTENTS
 
 
 
 
 
Page
PART I.
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II.
Item 1.
Item 1A.
Item 2.
Item 6.



Table of Contents

PART I. FINANCIAL INFORMATION
 
 
 
Item 1.
 
Financial Statements
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value amounts)
 
July 31,
2017
 
 October 31,
2016*
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,154,986

 
$
976,620

Short-term investments
147,508

 
140,695

      Total cash, cash equivalents and short-term investments
1,302,494

 
1,117,315

Accounts receivable, net
411,262

 
438,873

Income taxes receivable and prepaid taxes
55,750

 
56,091

Prepaid and other current assets
125,126

 
104,659

Total current assets
1,894,632

 
1,716,938

Property and equipment, net
262,025

 
257,035

Goodwill
2,660,680

 
2,518,245

Intangible assets, net
248,335

 
266,661

Long-term prepaid taxes
15,706

 
13,991

Deferred income taxes
382,495

 
281,926

Other long-term assets
215,066

 
185,569

Total assets
$
5,678,939

 
$
5,240,365

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
403,302

 
$
401,451

Accrued income taxes
16,270

 
22,693

Deferred revenue
1,046,801

 
1,085,802

Short-term debt
298,025

 
205,000

Total current liabilities
1,764,398

 
1,714,946

Long-term accrued income taxes
23,545

 
39,562

Long-term deferred revenue
83,001

 
79,856

Long-term debt
137,813

 

Other long-term liabilities
247,014

 
210,855

Total liabilities
2,255,771

 
2,045,219

Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value: 2,000 shares authorized; none outstanding

 

Common stock, $0.01 par value: 400,000 shares authorized; 150,238 and 151,454 shares outstanding, respectively
1,503

 
1,515

Capital in excess of par value
1,631,200

 
1,644,675

Retained earnings
2,277,499

 
1,947,585

Treasury stock, at cost: 7,024 and 5,811 shares, respectively
(419,370
)
 
(294,052
)
Accumulated other comprehensive income (loss)
(67,664
)
 
(104,577
)
Total stockholders’ equity
3,423,168

 
3,195,146

Total liabilities and stockholders’ equity
$
5,678,939

 
$
5,240,365

* Derived from audited financial statements.
See accompanying notes to unaudited condensed consolidated financial statements.

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Table of Contents

SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
Time-based products
$
503,530

 
$
479,285

 
$
1,493,991

 
$
1,427,740

Upfront products
100,251

 
66,885

 
263,310

 
168,485

Maintenance and service
91,600

 
69,034

 
270,935

 
192,588

Total revenue
695,381

 
615,204

 
2,028,236

 
1,788,813

Cost of revenue:
 
 
 
 
 
 
 
Products
107,104

 
92,042

 
304,982

 
253,879

Maintenance and service
43,828

 
23,172

 
122,618

 
67,328

Amortization of intangible assets
18,614

 
24,463

 
59,720

 
79,544

Total cost of revenue
169,546

 
139,677

 
487,320

 
400,751

Gross margin
525,835

 
475,527

 
1,540,916

 
1,388,062

Operating expenses:
 
 
 
 
 
 
 
Research and development
228,663

 
221,874

 
664,326

 
634,751

Sales and marketing
131,520

 
127,328

 
395,242

 
370,874

General and administrative
46,350

 
42,548

 
170,654

 
123,798

Amortization of intangible assets
7,906

 
7,055

 
23,806

 
21,014

Restructuring charges
6,026

 

 
31,038

 
2,987

Total operating expenses
420,465

 
398,805

 
1,285,066

 
1,153,424

Operating income
105,370

 
76,722

 
255,850

 
234,638

Other income (expense), net
7,421

 
8,509

 
27,322

 
12,158

Income before income taxes
112,791

 
85,231

 
283,172

 
246,796

Provision (benefit) for income taxes
(3,960
)
 
20,513

 
26,527

 
52,667

Net income
$
116,751

 
$
64,718

 
$
256,645

 
$
194,129

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.78

 
$
0.43

 
$
1.71

 
$
1.28

Diluted
$
0.75

 
$
0.42

 
$
1.66

 
$
1.26

Shares used in computing per share amounts:
 
 
 
 
 
 
 
Basic
150,214

 
151,169

 
150,460

 
152,129

Diluted
154,683

 
153,890

 
154,787

 
154,629

See accompanying notes to unaudited condensed consolidated financial statements.


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SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
 
 
 
 
Net income
$
116,751

 
$
64,718

 
$
256,645

 
$
194,129

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in foreign currency translation adjustment
3,026

 
(6
)
 
12,327

 
2,927

Changes in unrealized gains (losses) on available-for-sale securities, net of tax of $0 for periods presented
20

 
33

 
(34
)
 
92

Cash flow hedges:
 
 
 
 
 
 
 
Deferred gains (losses), net of tax of $(1,971) and $(4,917), for the three and nine months ended July 31, 2017, respectively, and of $1,828 and $3,112 for each of the same periods in fiscal 2016, respectively
8,517

 
(11,693
)
 
19,005

 
(21,286
)
Reclassification adjustment on deferred (gains) losses included in net income, net of tax of $232 and $(933), for the three and nine months ended July 31, 2017, respectively, and of $(1,469) and $(4,640), for each of the same periods in fiscal 2016, respectively
22

 
5,174

 
5,615

 
14,087

Other comprehensive income (loss), net of tax effects
11,585

 
(6,492
)
 
36,913

 
(4,180
)
Comprehensive income
$
128,336

 
$
58,226

 
$
293,558

 
$
189,949

See accompanying notes to unaudited condensed consolidated financial statements.


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SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Nine Months Ended 
 July 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
256,645

 
$
194,129

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization and depreciation
144,112

 
157,814

Stock compensation
79,697

 
72,043

Allowance for doubtful accounts
1,289

 
650

(Gain) loss on sale of investments
(1
)
 
(15
)
Write-down of long-term investments
1,300

 

Deferred income taxes
(10,960
)
 
2,747

Net changes in operating assets and liabilities, net of acquired assets and liabilities:
 
 
 
Accounts receivable
42,413

 
77,532

Prepaid and other current assets
(13,636
)
 
(22,941
)
Other long-term assets
(33,416
)
 
(8,118
)
Accounts payable and accrued liabilities
36,129

 
(41,749
)
Income taxes
(19,169
)
 
(3,314
)
Deferred revenue
(34,692
)
 
10,195

Net cash provided by operating activities
449,711

 
438,973

Cash flows from investing activities:
 
 
 
Proceeds from sales and maturities of short-term investments
130,529

 
111,078

Purchases of short-term investments
(137,486
)
 
(126,216
)
Proceeds from sales of long-term investments
839

 
1,785

Purchases of long-term investments

 
(1,002
)
Purchases of property and equipment
(50,227
)
 
(48,249
)
Cash paid for acquisitions and intangible assets, net of cash acquired
(187,624
)
 
(60,056
)
Capitalization of software development costs
(3,130
)
 
(2,959
)
Other
2,100

 

Net cash used in investing activities
(244,999
)
 
(125,619
)
Cash flows from financing activities:
 
 
 
Proceeds from credit facilities
270,000

 
185,000

Repayment of debt
(38,750
)
 
(112,500
)
Issuances of common stock
78,718

 
69,884

Payments for taxes related to net share settlement of equity awards
(35,376
)
 
(25,718
)
Purchase of equity forward contract

 
(25,000
)
Purchases of treasury stock
(300,000
)
 
(300,000
)
Other
(482
)
 
2,713

Net cash provided used in financing activities
(25,890
)
 
(205,621
)
Effect of exchange rate changes on cash and cash equivalents
(456
)
 
2,396

Net change in cash and cash equivalents
178,366

 
110,129

Cash and cash equivalents, beginning of year
976,620

 
836,188

Cash and cash equivalents, end of period
$
1,154,986

 
$
946,317

See accompanying notes to unaudited condensed consolidated financial statements.

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SYNOPSYS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business
Synopsys, Inc. (Synopsys or the Company) provides software, intellectual property and services used by designers across the entire silicon to software spectrum, from engineers creating advanced semiconductors to software developers ensuring the quality and security of their applications. The Company is a global leader in supplying the electronic design automation (EDA) software that engineers use to design and test integrated circuits (ICs), also known as chips. The Company also offers intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than design those circuits themselves. The Company provides software and hardware used to develop the electronic systems that incorporate chips and the software that runs on them. To complement these offerings, the Company provides technical services and support to help its customers develop advanced chips and electronic systems. The Company is also a leading provider of software tools and services that improve the quality and security of software code in a wide variety of industries, including electronics, financial services, energy, industrials, and automotive.
Note 2. Summary of Significant Accounting Policies
The Company has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its unaudited condensed consolidated balance sheets, results of operations, comprehensive income and cash flows. The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Synopsys’ Annual Report on Form 10-K for the fiscal year ended October 31, 2016 as filed with the SEC on December 12, 2016.
Use of Estimates. To prepare financial statements in conformity with U.S. GAAP, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates and may result in material effects on the Company’s operating results and financial position.
Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Fiscal Year End. The Company’s fiscal year ends on the Saturday nearest to October 31 and consists of 52 weeks, with the exception that approximately every five years, the Company has a 53-week year. Fiscal 2017 and 2016 are both 52-week years. The third fiscal quarters of fiscal 2017 and 2016 ended on July 29, 2017 and July 30, 2016, respectively, and the prior fiscal year ended on October 29, 2016. For presentation purposes, the unaudited condensed consolidated financial statements and accompanying notes refer to the closest calendar month end.
Note 3. Business Combinations
During the nine months ended July 31, 2017, the Company completed acquisitions with an aggregate total purchase consideration of $188.1 million, net of cash acquired. The Company assumed unvested stock options with a fair value of $4.4 million using the Black-Scholes option-pricing model and will expense the options over their remaining service periods on a straight-line basis. The Company does not consider these acquisitions to be material, individually or in the aggregate, to the Company’s consolidated financial statements. The preliminary purchase price allocations resulted in $132.7 million of goodwill, of which $11.9 million is deductible for tax purposes, and $64.9 million of acquired identifiable intangible assets valued using the income or cost methods. The intangible assets are being amortized over their respective useful lives ranging from one to seven years. The acquisition-related costs for these acquisitions totaling $4.1 million were expensed as incurred in the unaudited condensed consolidated statement of operations. The Company funded the acquisitions with existing cash and debt.
The preliminary fair value estimates for the assets acquired and liabilities assumed for all fiscal 2017 acquisitions are not yet finalized and may change as additional information becomes available during the respective

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measurement periods. The primary areas of those preliminary estimates relate to certain tangible assets and liabilities, identifiable intangible assets, and income taxes. Additional information, which existed as of the acquisition date but is yet unknown to the Company, may become known to the Company during the remainder of the measurement period, a period not to exceed 12 months from the acquisition date. Changes to the provisional amounts recorded as assets or liabilities during the measurement period may result in an adjustment to goodwill.
Note 4. Goodwill and Intangible Assets
Goodwill as of July 31, 2017 and October 31, 2016 consisted of the following:
 
(in thousands)
As of October 31, 2016
$
2,518,245

Additions
132,694

Effect of foreign currency translation
9,741

As of July 31, 2017
$
2,660,680


Intangible assets as of July 31, 2017 consisted of the following:
 
Gross
Assets
 
Accumulated
Amortization
 
Net Assets
 
(in thousands)
Core/developed technology
$
622,979

 
$
511,064

 
$
111,915

Customer relationships
276,704

 
160,188

 
116,516

Contract rights intangible
173,455

 
171,420

 
2,035

Trademarks and trade names
25,129

 
16,556

 
8,573

In-process research and development (IPR&D)(1)
4,600

 

 
4,600

Capitalized software development costs
32,772

 
28,076

 
4,696

Total
$
1,135,639

 
$
887,304

 
$
248,335

 
(1)
IPR&D is reclassified to core/developed technology upon completion or is written off upon abandonment.

Intangible assets as of October 31, 2016 consisted of the following:
 
Gross
Assets
 
Accumulated
Amortization
 
Net Assets
 
(in thousands)
Core/developed technology
$
610,812

 
$
460,722

 
$
150,090

Customer relationships
235,997

 
139,932

 
96,065

Contract rights intangible
171,248

 
162,183

 
9,065

Trademarks and trade names
20,729

 
13,821

 
6,908

Capitalized software development costs
29,642

 
25,109

 
4,533

Total
$
1,068,428

 
$
801,767

 
$
266,661

 

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Amortization expense related to intangible assets consisted of the following:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Core/developed technology
$
15,575

 
$
21,673

 
$
50,330

 
$
65,536

Customer relationships
6,834

 
6,333

 
20,569

 
18,820

Contract rights intangible
3,215

 
2,720

 
9,893

 
13,827

Trademarks and trade names
896

 
792

 
2,734

 
2,374

Capitalized software development costs(2)
1,002

 
927

 
2,968

 
2,764

Total
$
27,522

 
$
32,445

 
$
86,494

 
$
103,321

 
(2) Amortization of capitalized software development costs is included in cost of products revenue in the unaudited condensed consolidated statements of operations.
The following table presents the estimated future amortization of the existing intangible assets:
Fiscal Year
(in thousands)
Remainder of fiscal 2017
$
24,465

2018
82,650

2019
57,337

2020
39,478

2021
21,338

2022 and thereafter
18,467

IPR&D(3)
4,600

Total
$
248,335


(3) IPR&D assets are amortized over their useful lives upon completion or written off upon abandonment.

Note 5. Financial Assets and Liabilities
Cash equivalents and short-term investments. The Company classifies time deposits and other investments with maturities less than three months as cash equivalents. Debt securities and other investments with maturities longer than three months are classified as short-term investments. The Company’s investments generally have a term of less than three years and are classified as available-for-sale carried at fair value, with unrealized gains and losses included in the unaudited condensed consolidated balance sheets as a component of accumulated other comprehensive income (loss), net of tax. Those unrealized gains or losses deemed other than temporary are reflected in other income (expense), net. The cost of securities sold is based on the specific identification method and realized gains and losses are included in other income (expense), net.

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As of July 31, 2017, the balances of our available-for-sale securities are:
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses Less Than 12 Months
 
Gross
Unrealized
Losses 12 Months or Longer
 
Estimated
Fair Value(1)
 
(in thousands)
Cash equivalents:
 
 
 
 
 
 
 
 
 
Money market funds
$
510,086

 
$

 
$

 
$

 
$
510,086

Commercial paper
2,274

 

 

 

 
2,274

Certificates of deposit
1,600

 

 

 

 
1,600

Total:
$
513,960

 
$

 
$

 
$

 
$
513,960

Short-term investments:
 
 
 
 
 
 
 
 
 
U.S. government agency securities
$
17,982

 
$
2

 
$
(27
)
 
$
(4
)
 
$
17,953

Certificates of deposit
22,017

 

 

 

 
22,017

Commercial paper
23,507

 

 

 

 
23,507

Corporate debt securities
61,337

 
47

 
(23
)
 

 
61,361

Asset-backed securities
21,180

 
4

 
(15
)
 

 
21,169

Other
1,499

 
2

 

 

 
1,501

Total:
$
147,522

 
$
55

 
$
(65
)
 
$
(4
)
 
$
147,508

(1)
See Note 6. Fair Value Measures for further discussion on fair values of cash equivalents and short-term investments.

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As of October 31, 2016, the balances of our available-for-sale securities are:
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses Less Than 12 Continuous Months
 
Gross
Unrealized
Losses 12 Continuous Months or Longer
 
Estimated
Fair Value(1)
 
(in thousands)
Cash equivalents:
 
 
 
 
 
 
 
 
 
Money market funds
$
499,274

 
$

 
$

 
$

 
$
499,274

Commercial paper
1,498

 

 

 

 
1,498

Certificates of deposit
4,200

 

 

 

 
4,200

Total:
$
504,972

 
$

 
$

 
$

 
$
504,972

Short-term investments:
 
 
 
 
 
 
 
 
 
U.S. government agency securities
$
13,607

 
$
4

 
$
(8
)
 
$

 
$
13,603

Certificates of deposit
12,849

 

 

 

 
12,849

Commercial paper
25,430

 
1

 

 

 
25,431

Corporate debt securities
58,753

 
43

 
(18
)
 

 
58,778

Asset-backed securities
22,146

 
12

 
(12
)
 

 
22,146

Non-U.S. government agency securities
3,403

 

 
(3
)
 

 
3,400

Other
4,488

 

 

 

 
4,488

Total:
$
140,676

 
$
60

 
$
(41
)
 
$

 
$
140,695

(1)
See Note 6. Fair Value Measures for further discussion on fair values of cash equivalents and short-term investments.

As of July 31, 2017, the stated maturities of the Company's available-for-sale securities are:
 
Amortized Cost
 
Fair Value
 
(in thousands)
Due in 1 year or less
$
107,164

 
$
107,133

Due in 2-5 years
40,358

 
40,375

Total
$
147,522

 
$
147,508

Non-marketable equity securities. The Company’s strategic investment portfolio consists of non-marketable equity securities in privately-held companies. The securities accounted for under cost method investments are reported at cost net of impairment losses. Securities accounted for under equity method investments are recorded at cost plus the proportional share of the issuers’ income or loss, which is recorded in the Company’s other income (expense), net. The cost basis of securities sold is based on the specific identification method. Refer to Note 6. Fair Value Measures.
Derivatives. The Company recognizes derivative instruments as either assets or liabilities in the unaudited condensed consolidated financial statements at fair value and provides qualitative and quantitative disclosures about such derivatives. The Company operates internationally and is exposed to potentially adverse movements in foreign currency exchange rates. The Company enters into hedges in the form of foreign currency forward contracts to reduce its exposure to foreign currency rate changes on non-functional currency denominated forecasted transactions and balance sheet positions including: (1) certain assets and liabilities, (2) shipments forecasted to

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occur within approximately one month, (3) future billings and revenue on previously shipped orders, and (4) certain future intercompany invoices denominated in foreign currencies.
The duration of forward contracts ranges from approximately one month to 22 months, the majority of which are short-term. The Company does not use foreign currency forward contracts for speculative or trading purposes. The Company enters into foreign exchange forward contracts with high credit quality financial institutions that are rated ‘A’ or above and to date has not experienced nonperformance by counterparties. Further, the Company anticipates continued performance by all counterparties to such agreements.
The assets or liabilities associated with the forward contracts are recorded at fair value in other current assets or accrued liabilities in the unaudited condensed consolidated balance sheets. The accounting for gains and losses resulting from changes in fair value depends on the use of the foreign currency forward contract and whether it is designated and qualifies for hedge accounting.
Cash Flow Hedging Activities
Certain foreign exchange forward contracts are designated and qualify as cash flow hedges. These contracts have durations of approximately 22 months or less. Certain forward contracts are rolled over periodically to capture the full length of exposure to the Company’s foreign currency risk, which can be up to three years. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on the hedged transactions. The effective portion of gains or losses resulting from changes in fair value of these hedges is initially reported, net of tax, as a component of other comprehensive income (OCI) in stockholders’ equity and reclassified into revenue or operating expenses, as appropriate, at the time the hedged transactions affect earnings. The Company expects a majority of the hedge balance in OCI to be reclassified to the statements of operations within the next 12 months.
Hedging effectiveness is evaluated monthly using spot rates, with any gain or loss caused by hedging ineffectiveness recorded in other income (expense), net. The premium/discount component of the forward contracts is recorded to other income (expense), net, and is not included in evaluating hedging effectiveness.
Non-designated Hedging Activities
The Company’s foreign exchange forward contracts that are used to hedge non-functional currency denominated balance sheet assets and liabilities are not designated as hedging instruments. Accordingly, any gains or losses from changes in the fair value of the forward contracts are recorded in other income (expense), net. The gains and losses on these forward contracts generally offset the gains and losses associated with the underlying assets and liabilities, which are also recorded in other income (expense), net. The duration of the forward contracts for hedging the Company’s balance sheet exposure is approximately one month.

The Company also has certain foreign exchange forward contracts for hedging certain international revenues and expenses that are not designated as hedging instruments. Accordingly, any gains or losses from changes in the fair value of the forward contracts are recorded in other income (expense), net. The gains and losses on these forward contracts generally offset the gains and losses associated with the foreign currency in operating income. The duration of these forward contracts is usually less than one year. The overall goal of the Company’s hedging program is to minimize the impact of currency fluctuations on its net income over its fiscal year.
The effects of the changes in the fair values of non-designated forward contracts are summarized as follows:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Gain (loss) recorded in other income (expense), net
$
515

 
$
(2,193
)
 
$
1,838

 
$
(4,042
)

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The notional amounts in the table below for derivative instruments provide one measure of the transaction volume outstanding:
 
As of July 31, 2017
 
As of October 31, 2016
 
(in thousands)
Total gross notional amount
$
803,986

 
$
758,246

Net fair value
$
15,464

 
$
(15,358
)
The notional amounts for derivative instruments do not represent the amount of the Company’s exposure to market gain or loss. The Company’s exposure to market gain or loss will vary over time as a function of currency exchange rates. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.
The following represents the unaudited condensed consolidated balance sheet location and amount of derivative instrument fair values segregated between designated and non-designated hedge instruments:
 
Fair values of
derivative instruments
designated as hedging
instruments
 
Fair values of
derivative instruments
not designated as
hedging instruments
 
(in thousands)
As of July 31, 2017
 
 
 
Other current assets
$
17,017

 
$
306

Accrued liabilities
$
1,741

 
$
118

As of October 31, 2016
 
 
 
Other current assets
$
4,625

 
$
27

Accrued liabilities
$
19,910

 
$
101


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The following table represents the unaudited condensed consolidated statement of operations location and amount of gains and losses on derivative instrument fair values for designated hedge instruments, net of tax:
 
Location of gain (loss)
recognized in OCI on
derivatives
 
Amount of gain (loss)
recognized in OCI on
derivatives
(effective portion)
 
Location of
gain (loss)
reclassified from OCI
 
Amount of
gain (loss)
reclassified from
OCI
(effective portion)
 
(in thousands)
Three months ended 
 July 31, 2017
 
 
 
 
 
 
 
Foreign exchange contracts
Revenue
 
$
(176
)
 
Revenue
 
$
(198
)
Foreign exchange contracts
Operating expenses
 
8,747

 
Operating expenses
 
176

Total
 
 
$
8,571

 
 
 
$
(22
)
Three months ended 
 July 31, 2016
 
 
 
 
 
 
 
Foreign exchange contracts
Revenue
 
$
(5,443
)
 
Revenue
 
$
(2,900
)
Foreign exchange contracts
Operating expenses
 
(6,317
)
 
Operating expenses
 
(2,274
)
Total
 
 
$
(11,760
)
 
 
 
$
(5,174
)
Nine months ended 
 July 31, 2017
 
 
 
 
 
 
 
Foreign exchange contracts
Revenue
 
$
6,824

 
Revenue
 
$
(2,379
)
Foreign exchange contracts
Operating expenses
 
12,357

 
Operating expenses
 
(3,236
)
Total
 
 
$
19,181

 
 
 
$
(5,615
)
Nine months ended 
 July 31, 2016
 
 
 
 
 
 
 
Foreign exchange contracts
Revenue
 
$
(13,117
)
 
Revenue
 
$
(4,117
)
Foreign exchange contracts
Operating expenses
 
(8,262
)
 
Operating expenses
 
(9,970
)
Total
 
 
$
(21,379
)
 
 
 
$
(14,087
)
The following table represents the ineffective portions and portions excluded from effectiveness testing of the hedge gains (losses) for derivative instruments designated as hedging instruments, which are recorded in other income (expense), net:
Foreign exchange contracts
Amount of
gain (loss) recognized
in statement of operations
on derivatives
(ineffective
portion)(1)
 
Amount of gain (loss)
recognized in
statement of operations on
derivatives
(excluded from
effectiveness testing)(2)
 
(in thousands)
For the three months ended July 31, 2017
$
11

 
$
776

For the three months ended July 31, 2016
$
890

 
$
1,827

For the nine months ended July 31, 2017
$
175

 
$
3,393

For the nine months ended July 31, 2016
$
1,345

 
$
5,368


(1)
The ineffective portion includes forecast inaccuracies.
(2)
The portion excluded from effectiveness testing includes the discount earned or premium paid for the contracts.
Note 6. Fair Value Measures
Accounting Standards Codification (ASC) 820-10, Fair Value Measurements and Disclosures, defines fair value, establishes guidelines and enhances disclosure requirements for fair value measurements. The accounting guidance requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The accounting guidance also establishes a fair value hierarchy based on the

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independence of the source and objective evidence of the inputs used. There are three fair value hierarchies based upon the level of inputs that are significant to fair value measurement:
Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical instruments in active markets;
Level 2—Observable inputs other than quoted prices included in Level 1 for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-driven valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3—Unobservable inputs to the valuation derived from fair valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
On a recurring basis, the Company measures the fair value of certain of its assets and liabilities, which include cash equivalents, short-term investments, non-qualified deferred compensation plan assets, and foreign currency derivative contracts.
The Company’s cash equivalents and short-term investments are classified within Level 1 or Level 2 because they are valued using quoted market prices in an active market or alternative independent pricing sources and models utilizing market observable inputs.
The Company’s non-qualified deferred compensation plan assets consist of money market and mutual funds invested in domestic and international marketable securities that are directly observable in active markets and are therefore classified within Level 1.
The Company’s foreign currency derivative contracts are classified within Level 2 because these contracts are not actively traded and the valuation inputs are based on quoted prices and market observable data of similar instruments.
The Company’s borrowings under its credit and term loan facilities are classified within Level 2 because these borrowings are not actively traded and have a variable interest rate structure based upon market rates currently available to the Company for debt with similar terms and maturities. Refer to Note 8. Credit Facility.

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Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below as of July 31, 2017:
 
 
 
Fair Value Measurement Using
Description
Total
 
Quoted Prices in 
Active
Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
 
(in thousands)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
510,086

 
$
510,086

 
$

 
$

Commercial paper
2,274

 

 
2,274

 

Certificates of deposit
1,600

 

 
1,600

 

Short-term investments:
 
 
 
 
 
 
 
U.S. government agency securities
17,953

 

 
17,953

 

Certificates of deposit
22,017

 

 
22,017

 

Commercial paper
23,507

 

 
23,507

 

Corporate debt securities
61,361

 

 
61,361

 

Asset-backed securities
21,169

 

 
21,169

 

Other
1,501

 

 
1,501

 

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency derivative contracts
17,323

 

 
17,323

 

Other long-term assets:
 
 
 
 
 
 
 
Deferred compensation plan assets
191,013

 
191,013

 

 

Total assets
$
869,804

 
$
701,099

 
$
168,705

 
$

Liabilities
 
 
 
 
 
 
 
Accounts payable and accrued liabilities:
 
 
 
 
 
 
 
Foreign currency derivative contracts
$
1,859

 
$

 
$
1,859

 
$

Other long-term liabilities:
 
 
 
 
 
 
 
Deferred compensation plan  liabilities
191,013

 
191,013

 

 

Total liabilities
$
192,872

 
$
191,013

 
$
1,859

 
$


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Table of Contents

Assets and liabilities measured at fair value on a recurring basis are summarized below as of October 31, 2016:
 
 
 
Fair Value Measurement Using
Description
Total
 
Quoted Prices in 
Active
Markets for  Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable 
Inputs
(Level 3)
 
(in thousands)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
499,274

 
$
499,274

 
$

 
$

Commercial paper
1,498

 

 
1,498

 

Certificates of deposit
4,200

 

 
4,200

 

Short-term investments:
 
 
 
 
 
 
 
U.S. government agency securities
13,603

 

 
13,603

 

Certificates of deposit
12,849

 

 
12,849

 

Commercial paper
25,431

 

 
25,431

 

Corporate debt securities
58,778

 

 
58,778

 

Asset-backed securities
22,146

 

 
22,146

 

Non-U.S. government agency securities
3,400

 

 
3,400

 

Other
4,488

 
4,488

 

 

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency derivative contracts
4,652

 

 
4,652

 

Other long-term assets:
 
 
 
 
 
 
 
Deferred compensation plan assets
163,185

 
163,185

 

 

Total assets
$
813,504

 
$
666,947

 
$
146,557

 
$

Liabilities
 
 
 
 
 
 
 
Accounts payable and accrued liabilities:
 
 
 
 
 
 
 
Foreign currency derivative contracts
$
20,010

 
$

 
$
20,010

 
$

Other long-term liabilities:
 
 
 
 
 
 
 
Deferred compensation plan liabilities
163,185

 
163,185

 

 

Total liabilities
$
183,195

 
$
163,185

 
$
20,010

 
$


Assets/Liabilities Measured at Fair Value on a Non-Recurring Basis
Non-Marketable Equity Securities
Equity investments in privately-held companies, also called non-marketable equity securities, are accounted for using either the cost or equity method of accounting.
The non-marketable equity securities are measured and recorded at fair value when an event or circumstance which impacts the fair value of these securities indicates an other-than-temporary decline in value has occurred. In such events, these equity investments would be classified within Level 3 as they are valued using significant unobservable inputs or data in an inactive market, and the valuation requires management judgment due to the absence of market price and inherent lack of liquidity. The Company monitors these investments and generally uses the income approach to assess impairments based primarily on the financial conditions of these companies.
The Company did not recognize any impairment during the three months ended July 31, 2017 and recorded an $1.3 million of other-than-temporary impairment during the nine months ended July 31, 2017. The Company did not recognize any impairment during the three and nine months ended July 31, 2016.

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The following table presents the non-marketable equity securities that were measured and recorded at fair value within other long-term assets on a non-recurring basis and the loss recorded in other income (expense), net.
 
 
Balance as of July 31, 2017
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
(losses) during three months ended July 31, 2017
 
Total
(losses) during nine months ended July 31, 2017
 
(in thousands)
 
 
Non-marketable equity securities
$

 
$

 
$

 
$
(1,300
)
Note 7. Liabilities and Restructuring Charges
During the three and nine months ended July 31, 2017, the Company incurred restructuring charges of approximately $6.0 million and $31.0 million, respectively, for involuntary and voluntary employee termination actions. The restructuring actions were undertaken to structure the Company for future growth, reallocate resources to priority areas, and to a lesser extent, eliminate operational redundancy. During the three and nine months ended July 31, 2017, the Company made payments of $2.7 million and $21.5 million, respectively. Payments under the 2017 restructuring plans are expected to be completed by the end of the second quarter of fiscal 2018. 
In fiscal 2016, the Company incurred $9.6 million of restructuring charges for severance and benefits due to involuntary employee termination activities. As of July 31, 2017, there was no outstanding balance for the 2016 restructuring activities.
The following is a summary of restructuring activities during the nine months ended July 31, 2017:
 
(in thousands)
Liability as of October 31, 2016
$
5,679

Restructuring costs incurred
31,038

Cash payments
$
(21,523
)
As of July 31, 2017(1)
$
15,194

(1)
Outstanding balance recorded in accounts payable and accrued liabilities as payroll and related benefits.

Accounts payable and accrued liabilities consist of:
 
July 31,
2017
 
October 31,
2016
 
(in thousands)
Payroll and related benefits
$
297,755

 
$
321,430

Other accrued liabilities
85,674

 
66,276

Accounts payable
19,873

 
13,745

Total
$
403,302

 
$
401,451

Other long-term liabilities consist of:
 
July 31,
2017
 
October 31,
2016
 
(in thousands)
Deferred compensation liability
$
191,013

 
$
163,185

Other long-term liabilities
56,001

 
47,670

Total
$
247,014

 
$
210,855

Note 8. Credit Facility
On November 28, 2016, the Company entered into an amended and restated credit agreement with several lenders (the Credit Agreement) providing for (i) a $650.0 million senior unsecured revolving credit facility (the Revolver) and (ii) a $150.0 million senior unsecured term loan facility (the Term Loan). The Credit Agreement amended and restated the Company’s previous credit agreement dated May 19, 2015 (the 2015 Agreement), in order to increase the size of the revolving credit facility from $500.0 million to $650.0 million, provide a new $150.0 million senior

16

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unsecured term loan facility, and to extend the termination date of the revolving credit facility from May 19, 2020 to November 28, 2021. Subject to obtaining additional commitments from lenders, the principal amount of the loans provided under the Credit Agreement may be increased by the Company by up to an additional $150.0 million. The Credit Agreement contains financial covenants requiring the Company to operate within a maximum leverage ratio and a minimum interest coverage ratio, as well as other non-financial covenants. As of July 31, 2017, the Company was in compliance with all financial covenants.
During the first quarter of fiscal 2017, the Company received funding of $150.0 million under the Term Loan. Outstanding principal payments under the Term Loan are due as follows:
Fiscal year
(in thousands)
Remainder of fiscal 2017
$
1,875

2018
10,313

2019
14,062

2020
17,813

2021
27,187

2022
75,000

Total
$
146,250

As of July 31, 2017, the Company had a $145.8 million outstanding balance, net of debt issuance costs, under the Term Loan, of which $137.8 million is classified as long-term liabilities, and a $290.0 million outstanding balance under the Revolver, all of which are considered short-term liabilities. As of October 31, 2016, the Company had no outstanding balance under the previous term loan from the 2015 Agreement and a $205.0 million outstanding balance under the previous revolver from the 2015 Agreement, which are considered short-term liabilities. The Company expects its borrowings under the Revolver will fluctuate from quarter to quarter. Borrowings bear interest at a floating rate based on a margin over the Company’s choice of market observable base rates as defined in the Credit Agreement. As of July 31, 2017, borrowings under the Term Loan bore interest at LIBOR +1.125% and the applicable interest rate for the Revolver was LIBOR +1.000%. In addition, commitment fees are payable on the Revolver at rates between 0.125% and 0.200% per year based on the Company’s leverage ratio on the daily amount of the revolving commitment.
The carrying amount of the short-term and long-term debt approximates the estimated fair value. These borrowings under the Credit Agreement have a variable interest rate structure and are classified within Level 2 of the fair value hierarchy.
Note 9. Accumulated Other Comprehensive Income (Loss)
Components of accumulated other comprehensive income (loss), on an after-tax basis where applicable, were as follows:
 
July 31,
2017
 
October 31,
2016
 
(in thousands)
Cumulative currency translation adjustments
$
(72,373
)
 
$
(84,700
)
Unrealized gain (loss) on derivative instruments, net of taxes
4,724

 
(19,896
)
Unrealized gain (loss) on available-for-sale securities, net of taxes
(15
)
 
19

Total accumulated other comprehensive income (loss)
$
(67,664
)
 
$
(104,577
)
The effect of amounts reclassified out of each component of accumulated other comprehensive income (loss) into net income was as follows:

17

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Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Reclassifications from accumulated other comprehensive income (loss) into unaudited condensed consolidated statement of operations:
 
 
 
 
 
 
 
Gain (loss) on cash flow hedges, net of taxes
 
 
 
 
 
 
 
Revenues
$
(198
)
 
$
(2,900
)
 
$
(2,379
)
 
$
(4,117
)
Operating expenses
176

 
(2,274
)
 
(3,236
)
 
(9,970
)
Gain (loss) on available-for-sale securities
 
 
 
 
 
 
 
Other income (expense)
$

 
5

 
1

 
$
15

Total reclassifications into net income
$
(22
)
 
$
(5,169
)
 
$
(5,614
)
 
$
(14,072
)
Note 10. Stock Repurchase Program
The Company’s Board of Directors (the Board) previously approved a stock repurchase program pursuant to which the Company was authorized to purchase up to $500.0 million of its common stock, and has periodically replenished the stock repurchase program to such amount. The Board replenished the stock repurchase program up to $500.0 million on June 15, 2017. The program does not obligate the Company to acquire any particular amount of common stock, and the program may be suspended or terminated at any time by the Company's Chief Financial Officer or the Board. The Company repurchases shares to offset dilution caused by ongoing stock issuances from existing equity plans for equity compensation awards and issuances related to acquisitions, and when management believes it is a good use of cash. Repurchases are transacted in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended (the Exchange Act), and may be made through any means including, but not limited to, open market purchases, plans executed under Rule 10b5-1(c) of the Exchange Act and structured transactions. As of July 31, 2017, $500.0 million remained available for further repurchases under the program.

In December 2016, the Company entered into an accelerated share repurchase agreement (the December 2016 ASR) to repurchase an aggregate of $100.0 million of the Company’s common stock. Pursuant to the December 2016 ASR, the Company made a prepayment of $100.0 million and received initial share deliveries valued at $80.0 million. The remaining balance of $20.0 million was settled in February 2017. Total shares purchased under the December 2016 ASR were approximately 1.7 million shares, at an average purchase price of $60.53 per share.

In February 2017, the Company entered into an accelerated share repurchase agreement (the February 2017 ASR) to repurchase an aggregate of $100.0 million of the Company’s common stock. Pursuant to the February 2017 ASR, the Company made a prepayment of $100.0 million and received initial share deliveries valued at $80.0 million. The remaining balance of $20.0 million was settled in May 2017. Total shares purchased under the February 2017 ASR were approximately 1.4 million shares, at an average purchase price of $72.02 per share.

In May 2017, the Company entered into an accelerated share repurchase agreement (the May 2017 ASR) to repurchase an aggregate of $100.0 million of the Company’s common stock. Pursuant to the May 2017 ASR, the Company made a prepayment of $100.0 million and received initial share deliveries valued at $80.0 million. The remaining balance of $20.0 million was settled in July 2017. Total shares purchased under the May 2017 ASR were approximately 1.4 million shares, at an average purchase price of $73.49 per share.

18

Table of Contents

Stock repurchase activities are as follow:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Total shares repurchased (1)
1,627

 
2,525

 
4,401

 
6,889

Total cost of the repurchased shares(1)
$
120,000

 
$
120,000

 
$
300,000

 
$
320,000

Reissuance of treasury stock
1,316

 
1,708

 
3,188

 
3,169

(1)
The number of shares purchased and average purchase price paid per share includes the 265,894 shares and $20.0 million equity forward contract, respectively, from the February 2017 ASR settled in May 2017.
Note 11. Stock Compensation
The compensation cost recognized in the unaudited condensed consolidated statements of operations for the Company’s stock compensation arrangements was as follows:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Cost of products
$
3,358

 
$
2,912

 
$
9,170

 
$
8,116

Cost of maintenance and service
1,073

 
650

 
2,881

 
1,792

Research and development expense
13,617

 
13,046

 
39,069

 
36,469

Sales and marketing expense
5,494

 
5,139

 
15,430

 
14,581

General and administrative expense
4,759

 
3,824

 
13,147

 
11,085

Stock compensation expense before taxes
28,301

 
25,571

 
79,697

 
72,043

Income tax benefit
(8,086
)
 
(6,781
)
 
(22,769
)
 
(19,106
)
Stock compensation expense after taxes
$
20,215

 
$
18,790

 
$
56,928

 
$
52,937

In addition to the tax benefit disclosed above, the Company recorded net excess tax benefits from stock-based compensation in the provision for income taxes of $18.4 million and $29.7 million, respectively, for the three and nine months ended July 31, 2017. As of July 31, 2017, there was $223.5 million of unamortized share-based compensation expense relating to options and restricted stock units and awards, which is expected to be amortized over a weighted-average period of approximately 2.6 years.
The intrinsic values of equity awards exercised during the periods are as follows:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Intrinsic value of awards exercised
$
20,688

 
$
19,530

 
$
49,344

 
$
28,028

In March 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting." The Company elected to early adopt ASU 2016-09 in the first quarter of fiscal 2017. As required by ASU 2016-09, excess tax benefits recognized on stock-based compensation expense are classified as an operating activity in the consolidated statements of cash flows and the Company has elected to apply this provision on a prospective basis. The Company also elected to account for forfeitures as they occur and recorded a one-time adoption expense of $0.4 million to retained earnings. See Note 15. Taxes for additional information on tax impacts.
Note 12. Net Income per Share
The Company computes basic net income per share by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share reflects the dilution from potential common shares outstanding, such as stock options and unvested restricted stock units and awards, during the period using the treasury stock method.

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Table of Contents

The table below reconciles the weighted-average common shares used to calculate basic net income per share with the weighted-average common shares used to calculate diluted net income per share:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except per share amounts)
Numerator:
 
 
 
 
 
 
 
Net income
$
116,751

 
$
64,718

 
$
256,645

 
$
194,129

Denominator:
 
 
 
 
 
 
 
Weighted-average common shares for basic net income per share
150,214

 
151,169

 
150,460

 
152,129

Dilutive effect of potential common shares from equity-based compensation
4,469

 
2,721

 
4,327

 
2,500

Weighted-average common shares for diluted net income per share
154,683

 
153,890

 
154,787

 
154,629

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.78

 
$
0.43

 
$
1.71

 
$
1.28

Diluted
$
0.75

 
$
0.42

 
$
1.66

 
$
1.26

Anti-dilutive employee stock-based awards excluded(1)
492

 
2,270

 
1,186

 
1,822


(1)
These employee stock-based awards were anti-dilutive for the respective periods and are excluded in calculating diluted net income per share. While such awards were anti-dilutive for the respective periods, they could be dilutive in the future.
Note 13. Segment Disclosure
Certain disclosures are required for operating segments, products and services, geographic areas of operation and major customers. Segment reporting is based upon the “management approach,” i.e., how management organizes the Company’s operating segments for which separate financial information is (1) available and (2) evaluated regularly by the Chief Operating Decision Makers (CODMs) in deciding how to allocate resources and in assessing performance. Synopsys’ CODMs are the Company’s two Co-Chief Executive Officers.
The Company operates in a single segment to provide software products and consulting services primarily in the EDA software industry. In making operating decisions, the CODMs primarily consider consolidated financial information, accompanied by disaggregated information about revenues by geographic region. Specifically, the CODMs consider where individual “seats” or licenses to the Company’s products are located in allocating revenue to particular geographic areas. Revenue is defined as revenues from external customers. Goodwill is not allocated since the Company operates in one reportable operating segment. Revenues related to operations in the United States and other geographic areas were:
 
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
United States
$
358,201

 
$
316,902

 
$
1,028,108

 
$
889,220

Europe
80,260

 
66,946

 
234,259

 
211,993

Japan
64,119

 
63,056

 
183,023

 
174,838

Asia-Pacific and Other
192,801

 
168,300

 
582,846

 
512,762

Consolidated
$
695,381

 
$
615,204

 
$
2,028,236

 
$
1,788,813

Geographic revenue data for multi-region, multi-product transactions reflect internal allocations and are therefore subject to certain assumptions and the Company’s methodology.

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For the three and nine months ended July 31, 2017 and 2016, one customer, including its subsidiaries, through multiple agreements accounted for greater than 10% of the Company's total revenues.

Note 14. Other Income (Expense), net
The following table presents the components of other income (expense), net:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Interest income
$
2,015

 
$
1,031

 
$
4,747

 
$
2,499

Interest expense
(2,320
)
 
(1,208
)
 
(5,487
)
 
(2,729
)
Gain (loss) on assets related to executive deferred compensation plan assets
6,791

 
6,822

 
22,334

 
6,136

Foreign currency exchange gain (loss)
278

 
(94
)
 
2,877

 
(296
)
Other, net
657

 
1,958

 
2,851

 
6,548

Total
$
7,421

 
$
8,509

 
$
27,322

 
$
12,158

Note 15. Taxes
Effective Tax Rate
The Company estimates its annual effective tax rate at the end of each fiscal quarter. The effective tax rate takes into account the Company's estimations of annual pre-tax income, the geographic mix of pre-tax income and interpretations of tax laws and possible outcomes of audits.
The following table presents the provision (benefit) for income taxes and the effective tax rates:
 
Three Months Ended 
 July 31,
 
Nine Months Ended 
 July 31,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Income before income taxes
$
112,791

 
$
85,231

 
$
283,172

 
$
246,796

Provision (benefit) for income taxes
$
(3,960
)
 
$
20,513

 
$
26,527

 
$
52,667

Effective tax rate
(3.5
)%
 
24.1
%
 
9.4
%
 
21.3
%
The Company’s effective tax rate for the three and nine months ended July 31, 2017 is lower than the statutory federal income tax rate of 35% primarily due to lower taxes on certain earnings considered as indefinitely reinvested in foreign operations, U.S. federal and California research tax credits and excess tax benefits from stock-based compensation, partially offset by state taxes and the tax effect of non-deductible stock-based compensation and the integration of acquired technologies. The integration of acquired technologies represents the income tax effect resulting from the transfer of certain intangible assets among company-controlled entities.
The Company's effective tax rate decreased in the three and nine months ended July 31, 2017, as compared to the same periods in fiscal 2016, primarily due to excess tax benefits from stock-based compensation, partially offset by the permanent reinstatement of the U.S. federal research tax credit in the first quarter of fiscal 2016.
On December 18, 2015, the president signed into law the Protecting Americans from Tax Hikes Act of 2015 which permanently reinstated the research tax credit retroactive to January 1, 2015. As a result of the new legislation, the Company recognized a benefit in the first quarter of fiscal 2016 related to ten months of fiscal 2015 and two months of fiscal 2016 as well as a benefit to the annual effective tax rate for ten months of fiscal 2016.
On July 27, 2015, the United States Tax Court (Tax Court) issued an opinion (Altera Corp. et al. v. Commissioner) regarding the treatment of stock-based compensation expense in intercompany cost-sharing arrangements. The U.S. Treasury has not withdrawn the requirement to include stock-based compensation from its regulations and the IRS has initiated an appeal of the Tax Court's opinion. As the final resolution with respect to historical cost-sharing of stock-based compensation, and the potential favorable benefits to the Company, is unclear, the Company is recording no impact at this time and will continue to monitor developments related to this opinion and the potential impact of those developments on the Company's prior fiscal years. Effective February 1, 2016, the Company

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amended its cost-sharing arrangement to exclude stock-based compensation expense on a prospective basis and has reflected the corresponding benefits in its effective annual tax rate.
The timing of the resolution of income tax examinations is highly uncertain, as are the amounts and timing of various tax payments that are part of the settlement process. This could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities. The Company believes that in the coming 12 months, it is reasonably possible that either certain audits will conclude or the statute of limitations on certain state and foreign income and withholding taxes will expire, or both. Given the uncertainty as to ultimate settlement terms, the timing of payment and the impact of such settlements on other uncertain tax positions, the range of the estimated potential decrease in underlying unrecognized tax benefits is between $0 and $15 million.
As discussed in Note 11, the Company adopted ASU 2016-09 in the first quarter of fiscal 2017. The Company recorded all income tax effects of share-based awards in its provision for income taxes in the condensed consolidated statement of operations on a prospective basis. Prior to adoption, the Company did not recognize excess tax benefits from stock-based compensation as a charge to capital in excess of par value to the extent that the related tax deduction did not reduce income taxes payable. Upon adoption of ASU 2016-09, the Company recorded a deferred tax asset of $106.5 million for the previously unrecognized excess tax benefits with an offsetting adjustment to retained earnings. Adoption of the new standard resulted in net excess tax benefits in the provision for income taxes of $29.7 million for the nine months ended July 31, 2017.
State Examinations
In the first quarter of fiscal 2016, the Company reached final settlement with the California Franchise Tax Board for fiscal 2011, 2010 and 2009. As a result of the settlement, the Company reduced its deferred tax assets by $4.9 million, recognized $10.3 million in unrecognized tax benefits, and increased its valuation allowance by $5.4 million.
Non-U.S. Examinations

In July 2017, the Hungarian Tax Authority (HTA) issued a final assessment against the Company’s Hungarian subsidiary (Synopsys Hungary) for fiscal years 2011 through 2013. The HTA has disallowed Synopsys Hungary's tax positions taken during these years regarding the timing of the deduction of research expenses and applied withholding taxes on certain payments made to affiliates, resulting in an aggregate tax assessment of approximately $47 million and interest and penalties of over $18 million (at current exchange rates). In addition, if the treatment of research expenses were applied to fiscal years after 2014, Synopsys Hungary could lose approximately $18 million in tax benefit in tax periods subsequent to fiscal 2017 due to the enacted reduction of Hungary’s corporate income tax rate. While the ultimate outcome is not certain, the Company believes there is no merit to the assessment and believes that it will ultimately prevail against the positions taken by the HTA. To that end, on August 2, 2017, Synopsys Hungary filed a claim contesting the final assessment with the Hungarian Administrative Court. If the Company prevails, the assessment of $47 million would be canceled, but the Hungarian statutory accounting treatment could have an indirect adverse impact on certain tax benefits in the year of the cancellation.

In the third quarter of fiscal 2017, the Company settled certain transfer pricing issues with the Korean National Tax Service for fiscal years 2012 to 2016. As a result of the settlement, the Company recognized income tax expense of $7.9 million. The Company also reached agreement with the Taiwanese tax authorities on certain tax positions for fiscal year 2014, resulting in an income tax benefit of $10.9 million

In the third quarter of fiscal 2016, the Company reached final settlement with the Taiwan tax authorities for fiscal 2011, with regard to certain transfer pricing issues. As a result of the settlement, the Company paid $0.3 million of tax and recognized $0.7 million in unrecognized tax benefits.

In the second quarter of fiscal 2016, the Company agreed to settle certain transfer pricing issues with the Indian tax authorities for fiscal years 2010 to 2015. As a result of the settlement, the Company recognized income tax expense, net of foreign tax credits, of $2.4 million.

The Company undergoes tax examinations from time to time and is currently under examination by the tax authorities in certain other jurisdictions. No material assessments have been proposed in these examinations.


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Note 16. Contingencies
Legal Proceedings

The Company is subject to routine legal proceedings, as well as demands, claims and threatened litigation that arise in the normal course of its business. The ultimate outcome of any litigation is uncertain and unfavorable outcomes could have a negative impact on the Company’s results of operations and financial condition. The Company reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount is estimable, the Company accrues a liability for the estimated loss. The Company has determined that, except as set forth below, no disclosure of estimated loss is required for a claim against the Company because: (1) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (2) a reasonably possible loss or range of loss cannot be estimated; or (3) such estimate is immaterial.
Mentor Patent Litigation
The Company is engaged in complex patent litigation with Mentor Graphics Corporation (Mentor) involving several actions in different forums. The Company succeeded to the litigation when it acquired Emulation & Verification Engineering S.A. (EVE) on October 4, 2012. At the time of the acquisition, EVE and EVE-USA, Inc. (collectively, the EVE Parties) had been defendants in three patent infringement lawsuits filed by Mentor. Each lawsuit as well as subsequent lawsuits are further described below.
Background
As mentioned above, at the time of the acquisition, the EVE Parties had been defendants in three patent infringement lawsuits filed by Mentor. Mentor filed suit against the EVE Parties in federal district court in the District of Oregon on August 16, 2010 alleging that EVE’s ZeBu products infringed Mentor’s United States Patent No. 6,876,962. Mentor filed an additional suit in federal district court in the District of Oregon on August 17, 2012 alleging that EVE’s ZeBu products infringed Mentor’s United States Patent No. 6,947,882. Both cases sought damages and a permanent injunction.
On September 27, 2012, the Company and the EVE Parties filed an action for declaratory relief against Mentor in federal district court in the Northern District of California, seeking a determination that Mentor’s United States Patents Nos. 6,009,531, 5,649,176, and 6,240,376, which were the subject of a patent infringement lawsuit filed by Mentor against EVE in 2006 and settled in the same year, are invalid and not infringed by EVE’s products. Mentor asserted patent infringement counterclaims in this action based on the same three patents and sought damages and a permanent injunction. In April 2013, this action was transferred to the federal district court in Oregon and consolidated with the two Mentor lawsuits in that district (the Oregon Action), as further described below.
The Oregon Action
After transfer of the Company’s declaratory relief action to Oregon and consolidation of that action with Mentor’s 2010 and 2012 lawsuits, the Company asserted patent infringement counterclaims against Mentor based on the Company’s United States Patents Nos. 6,132,109 and 7,069,526, seeking damages and a permanent injunction. After pre-trial summary judgment rulings in favor of both sides, the only patent remaining at issue in the Oregon Action was Mentor's ‘376 patent.
The Oregon Action went to trial on the remaining Mentor patent, and a jury reached a verdict on October 10, 2014 finding that certain features of the ZeBu products infringed the ‘376 patent and assessing damages of approximately $36 million. On March 12, 2015, the court entered an injunction prohibiting certain sales activities relating to the features found by the jury to infringe. The Company released a new version of ZeBu software that does not include such features. The Company accrued an immaterial amount as a loss contingency in the quarter ended October 31, 2015. Both parties appealed from the court’s judgment following the jury verdict.
The Federal Circuit heard the parties’ respective appeals and issued a decision on March 16, 2017. The panel affirmed the jury verdict and damages award on Mentor’s ‘376 patent and reversed the district court’s dismissal of Mentor’s ‘176, ‘531 and ‘882 patents and the Company’s ‘109 patent. Proceedings on these patents will resume in the federal district court in Oregon, including trial of alleged supplemental damages on and willful infringement of the ‘376 patent. On May 1, 2017, the Company petitioned for rehearing by all judges currently sitting on the Federal Circuit. On May 9, 2017, the Federal Circuit invited Mentor to respond to the petition on or before May 23, 2017. Mentor responded to the petition on May 23, 2017. The Federal Circuit has not yet ruled on the Company's petition.

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Due to the affirmation of the verdict by the Federal Circuit, the Company has accrued an aggregate amount of $39.0 million as a loss contingency, which is the amount estimated to be the probable loss. The associated charge has been recorded in general and administrative expenses in the income statements for the nine months ended July 31, 2017.
The California Action
On December 21, 2012, the Company filed an action for patent infringement against Mentor in federal district court in the Northern District of California, alleging that Mentor’s Veloce products infringe the Company’s United States Patents Nos. 5,748,488, 5,530,841, 5,680,318 and 6,836,420 (the California Action). This case sought damages and a permanent injunction. The court stayed the action as to the ‘420 patent pending the U.S. Patent and Trademark Office's inter partes review of that patent and appeals from that proceeding. On January 20, 2015, the court granted Mentor's motion for summary judgment on the ‘488, ‘841, and ‘318 patents, finding that such patents were invalid. The Company appealed the court's ruling and on October 17, 2016, the Federal Circuit affirmed the district court’s decision. The Company is currently seeking review of the Federal Circuit’s ruling in the U.S. Supreme Court.
PTO Proceedings
On September 26, 2012, the Company filed two inter partes review requests with the U.S. Patent and Trademark Office (the PTO) challenging the validity of Mentor’s ‘376 and ‘882 patents. The PTO granted review of the ‘376 patent and denied review of the ‘882 patent. On February 19, 2014, the PTO issued its final decision in the review of the ‘376 patent, finding some of the challenged claims invalid and some of the challenged claims valid. On April 22, 2014, the Company appealed to the Federal Circuit from the PTO’s decision finding certain claims valid. Mentor filed a cross-appeal on May 2, 2014 from the PTO's decision finding certain claims invalid. On February 10, 2016, the Federal Circuit affirmed the PTO's decision in all respects.
On December 21, 2013, Mentor filed an inter partes review request with the PTO challenging the validity of the Company’s ‘420 patent. On June 11, 2015, the PTO issued its final decision in the review, finding all of the challenged claims invalid. On August 12, 2015, the Company appealed to the Federal Circuit from the PTO's decision. On October 11, 2016, the Federal Circuit affirmed the PTO’s decision.
On September 30, 2016, the Company filed a petition requesting ex parte reexamination of all of the claims of the ‘376 patent asserted in the Oregon Action. Mentor objected on procedural grounds. On November 8, 2016, the PTO instituted reexamination of the ‘376 patent. On December 15, 2016, the PTO vacated its decision to institute reexamination based upon Mentor’s procedural objection. The Company thereafter filed a renewed request for ex parte reexamination of only Claims 24, 26 and 27 of the patent, which was granted by the PTO in February 2017. On May 2, 2017, the Company also sued the PTO in federal district court in the Eastern District of Virginia, challenging the PTO’s decision not to institute reexamination of Claims 1 and 28. On May 22, 2017, the Company petitioned for ex parte reexamination of certain claims of the ‘882 patent.  On June 20, 2017, the PTO instituted reexamination on all of the challenged claims.  The ex parte reexamination and the lawsuit are ongoing.
While the Company intends to defend all of the above matters vigorously, the ultimate outcome of any litigation, including the litigation with Mentor, is uncertain and may have an adverse outcome resulting in losses beyond recorded amounts. In the event of an unfavorable final outcome, there exists the possibility of a material adverse impact on the Company's consolidated financial statements for the period in which the effects become reasonably estimable.
Tax Matters
The Company undergoes examination from time to time by U.S. and foreign authorities for non-income based taxes, such as sales, use and value-added taxes, and is currently under examination by tax authorities in certain jurisdictions. If the potential loss from such examinations is considered probable and the amount or the range of loss could be estimated, the Company would accrue a liability for the estimated expense.
In addition to the foregoing, the Company is, from time to time, party to various other claims and legal proceedings in the ordinary course of our business, including with tax and other governmental authorities. For a description of certain of these other matters, refer to Note 15. Taxes.
Note 17. Effect of New Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, "Revenue from Contracts with Customers (Topic 606)," which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605).” This ASU requires an entity to recognize revenue when goods are transferred or services are provided to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for

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those goods or services. This ASU also requires disclosures enabling users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
Since the issuance of Topic 606, the FASB has issued several amendments to the ASU, including deferral of the adoption date initially proposed, clarification on accounting for licenses of intellectual property, and identifying performance obligations.
Topic 606 will be effective for the Company beginning in fiscal 2019, including interim periods within that reporting period. The ASU permits two retrospective methods for adoption. The Company currently anticipates adopting Topic 606 using the modified retrospective method under which the cumulative effect of initially applying the guidance is recognized at the date of initial application.
The Company derives the majority of its total revenue from Technology Subscription License (TSL) contracts. The Company believes that the promised licenses of software (i.e., functional intellectual property) and the promise to provide substantive, timely, and technologically relevant updates in its TSL contracts reflect inputs to a combined item that represents a single overall promise to provide customer access to a suite of EDA software in an integrated solution that will evolve as our customers’ industries evolve through rapid technology changes. Accordingly, the Company has concluded that this single overall promise will be recognized as revenue over the term of the contract period. Accordingly, the Company expects that there will be no significant change in the nature and timing of revenue recognition for our TSL contracts under Topic 606.
The timing of revenue recognition for the Company’s upfront products, maintenance and professional services is expected to remain substantially unchanged.
The Company continues to assess all potential impacts of Topic 606 on other multiple element software arrangements that combine many software-related deliverables. As the requirement to have Vendor-Specific Objective Evidence (VSOE) for undelivered elements is not necessary to separate revenue from delivered software licenses, which is an essential criterion for separation under current standard, revenue would no longer be recognized over the arrangement period for certain of the Company's term licenses and IP licenses. The Company is currently in the process of evaluating the impact of these changes on the remainder of its arrangements.
Topic 606 also requires the deferral of incremental costs of obtaining a contract with a customer. This will require the Company to capitalize incremental costs such as commissions and other costs directly related to obtaining customer contracts and amortize those costs over the period the assets are expected to contribute future cash flows, which will be over the life of the contract. Under the existing rules, the Company expenses commissions based on shipments.
In February 2016, the FASB issued ASU 2016-2, "Leases (Topic 842)," which supersedes the lease requirements in "Leases (Topic 840)." This ASU requires a lessee to recognize a right-of-use asset and a lease payment liability for most leases in the Consolidated Statement of Financial Position. This ASU also makes some changes to lessor accounting and aligns with the new revenue recognition guidance. This ASU will be effective for fiscal 2020, including interim periods within that reporting period, and earlier adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements and related disclosures.
In October 2016, the FASB issued ASU 2016-16, "Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory.” This ASU requires the immediate recognition of current and deferred income tax effects of intra-entity transfers of assets other than inventory. This ASU will be effective for fiscal 2019, including interim periods within that reporting period, and earlier adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.
 

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Item 2.
  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q, includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which are subject to the “safe harbor” created by those sections. Any statements herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, words such as “may,” “will,” “could,” “would,” “can,” “should,” “anticipate,” “expect,” “intend,” “believe,” “estimate,” “project,” “continue,” "forecast," or the negatives of such terms, and similar expressions intended to identify forward-looking statements. Without limiting the foregoing, forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements concerning expected growth in the semiconductor industry and the effects of industry and customer consolidation, our business outlook, our business model, our growth strategy, the ability of our prior acquisitions to drive revenue growth, the sufficiency of our cash, cash equivalents and short-term investments and cash generated from operations, our future liquidity requirements, and other statements that involve certain known and unknown risks, uncertainties and other factors that could cause our actual results, time frames or achievements to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those identified below in Part II, Item 1A. Risk Factors of this Quarterly Report on Form 10-Q. The information included herein represents our estimates and assumptions as of the date of this filing. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. All subsequent written or oral forward-looking statements attributable to Synopsys or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and in other documents we file from time to time with the Securities and Exchange Commission (SEC) that attempt to advise interested parties of the risks and factors that may affect our business.
The following summary of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this report and with our audited consolidated financial statements and the related notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2016, as filed with the SEC on December 12, 2016.
Overview
Business Summary
Synopsys, Inc. provides software, intellectual property, and services used by designers across the entire silicon to software spectrum, from engineers creating advanced semiconductors to software developers seeking to ensure the quality and security of their applications. We are a global leader in supplying the electronic design automation (EDA) software that engineers use to design and test ICs, also known as chips. We also offer intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than design those circuits themselves. We provide software and hardware used to develop the electronic systems that incorporate chips and the software that runs on them. To complement these offerings, we provide technical services and support to help our customers develop advanced chips and electronic systems. We are also a leading provider of software tools and services that improve the quality and security of software code in a wide variety of industries, including electronics, financial services, energy, industrials, and automotive.
Our EDA and IP customers are generally semiconductor and electronics systems companies. Our solutions help these companies overcome the challenges of developing increasingly advanced electronics products while also helping them reduce their design and manufacturing costs. While our products are an important part of our customers’ development process, their research and development budget and spending decisions may be affected by their business outlook and willingness to invest in new and increasingly complex chip designs. In addition, several consolidations have taken place in the semiconductor industry recently. While we do not believe customer consolidations have had a material impact on our results, the future impact is uncertain. For a discussion of potential risks, please see the risk factor titled “Consolidation among our customers and within the industries in which we operate, as well as our dependence on a relatively small number of large customers, may negatively impact our operating results.” in Part II, Item 1A, Risk Factors.

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Despite global economic uncertainty, we have maintained profitability and positive cash flow on an annual basis in recent years. We achieved these results not only because of our solid execution, leading technologies and strong customer relationships, but also because of our time-based revenue business model. Under this model, a substantial majority of our customers pay over time and we typically recognize this revenue over the life of the contract, which averages approximately three years. Time-based revenue consists of time-based products, maintenance and service revenue. The revenue we recognize in a particular period generally results from selling efforts in prior periods rather than the current period. Due to our business model, decreases as well as increases in customer spending do not immediately affect our revenues in a significant way.
Our growth strategy is based on building on our leadership in our EDA products, expanding and proliferating our IP offerings, and driving growth in the software quality and security market. As we continue to expand our product portfolio and our total addressable market, for instance in the software quality and security space, and as hardware product sales grow, we may experience increased variability in our total revenue, though we expect time-based revenue to continue to represent at least 90% of all revenue other than hardware revenue. Overall, our business outlook remains solid based on our leading technologies, customer relationships, business model, diligent expense management, and acquisition strategy. We believe that these factors will help us continue to execute our strategies successfully.
Financial Performance Summary
In the third quarter of fiscal 2017, compared to the same period of fiscal 2016:
Revenues were $695.4 million, an increase of $80.2 million, or 13%, primarily driven by the overall growth in our business such as increases of hardware sales, IP consulting projects and TSL license revenues, and to a lesser extent from acquisitions.
Total cost of revenue and operating expenses were $590.0 million, an increase of $51.5 million, or 10%, primarily due to increases in headcount, including those from acquisitions, and higher product and consulting costs due to higher sales. 
Operating income of $105.4 million, an increase of $28.6 million or 37%.
During the three-month period ended July 31, 2017, 86% of our revenue was time-based.
New Accounting Pronouncements
See Note 17 of the Notes to Unaudited Condensed Consolidated Financial Statements.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial results under the heading “Results of Operations” below are based on our unaudited condensed consolidated financial statements, which we have prepared in accordance with U.S. GAAP. In preparing these financial statements, we make assumptions, judgments and estimates that can affect the reported amounts of assets, liabilities, revenues and expenses and net income. On an ongoing basis, we evaluate our estimates based on historical experience and various other assumptions we believe are reasonable under the circumstances. Our actual results may differ from these estimates.
The accounting policies that most frequently require us to make assumptions, judgments and estimates, and therefore are critical to understanding our results of operations, are:
Revenue recognition;
Valuation of business combinations;
Valuation of intangible assets; and
Income taxes.
Our critical accounting policies and estimates are discussed in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended October 31, 2016, filed with the SEC on December 12, 2016.

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Results of Operations
Revenue Background
We generate our revenue from the sale of products that include software licenses, maintenance and services, and to a lesser extent, hardware products. Software license revenue consists of fees associated with the licensing of our software. Maintenance and service revenue consists of maintenance fees associated with perpetual licenses and professional services fees. Hardware revenue consists of sales of Field Programmable Gate Array (FPGA)-based emulation and prototyping products.
Most of our customer arrangements are complex, involving hundreds of products and various license rights, bundled with post-contract customer support and additional meaningful rights that provide a complete end-to-end solution to the customer. Throughout the contract, our customers are typically using a myriad of products to complete each phase of a chip design and are concurrently working on multiple chip designs, or projects, in different phases of the design. During this time, the customer looks to us to release state-of-the-art technology as we keep up with the pace of change, to address requested enhancements to our tools to meet customer specifications, to provide support at each stage of the customer’s design, including the final manufacturing of the chip (the tape-out stage), and other important services.
With respect to software licenses, we utilize primarily two license types:
Technology Subscription Licenses (TSLs). TSLs are time-based licenses for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future technology. The majority of our arrangements are TSLs due to the nature of the business and customer requirements. In addition to the licenses, the arrangements also include: post-contract customer support, which includes providing frequent updates and upgrades to maintain the utility of the software due to rapid changes in technology; other intertwined services such as multiple copies of the tools; assisting our customers in applying our technology in their development environment; and rights to remix licenses for other licenses.
Perpetual licenses. Perpetual licenses continue as long as the customer renews maintenance plus an additional 20 years. Perpetual licenses do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually.
For the two software license types, we recognize revenue as follows:
TSLs. We typically recognize revenue from TSL fees ratably over the term of the license period, or as customer installments become due and payable, whichever is later. Revenue attributable to TSLs is reported as “time-based products revenue” in the unaudited condensed consolidated statements of operations.
Perpetual licenses. We recognize revenue from perpetual licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these perpetual licenses is reported as “upfront products revenue” in the unaudited condensed consolidated statements of operations. For perpetual licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer installments become due and payable. Such revenue is reported as “time-based products revenue” in the unaudited condensed consolidated statements of operations.
Under current accounting rules and policies, we recognize revenue from orders we receive for software licenses, services and hardware products at varying times.
In most instances, we recognize revenue on a TSL software license order over the license term and on a term or perpetual software license order in the quarter in which the license is delivered. The weighted-average term of the TSLs and term licenses is typically three years, but varies from quarter to quarter due to the nature and timing of the arrangements entered into during the quarter. For the three months ended July 31, 2017 and 2016, the weighted-average license term was 2.5 and 3.1 years, respectively.
Revenue on contracts requiring significant modification or development is accounted for using the percentage of completion method over the period of the development.
Revenue on hardware product orders is generally recognized in full at the time the product is shipped and when title is transferred.

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Contingent revenue is recognized if and when the event that removes the contingency occurs.
Revenue on maintenance orders is recognized ratably over the maintenance period (normally one year).
Revenue on professional services orders is generally recognized as the services are performed.
Infrequently, we enter into certain license arrangements wherein licenses are provided for a finite term without any other services or rights, including rights to receive, or to exchange licensed software for, unspecified future technology. We recognize revenue from term licenses in full upon shipment of the software and when all other revenue recognition criteria are met.
Our revenue in any period is equal to the sum of our time-based products, upfront products, and maintenance and services for the period. We derive time-based products revenue largely from TSL orders received and delivered in prior quarters and to a smaller extent from contracts in which revenue is recognized as customer installments become due and payable and from contingent revenue arrangements. We derive upfront products revenue directly from term and perpetual license and hardware product orders mostly booked and shipped during the period. We derive maintenance revenue largely from maintenance orders received in prior periods since our maintenance orders generally yield revenue ratably over a term of one year. We also derive professional services revenue primarily from orders received in prior quarters, since we recognize revenue from professional services as those services are delivered and accepted or on percentage of completion for arrangements requiring significant modification of our software, and not when they are booked.
Our revenue is sensitive to the mix of TSLs and perpetual licenses delivered during a reporting period. A TSL order typically yields lower current quarter revenue but contributes to revenue in future periods. For example, a $120,000 order for a three-year TSL delivered on the last day of a quarter typically generates no revenue in that quarter, but $10,000 in each of the 12 succeeding quarters. Conversely, a $120,000 order for perpetual licenses with greater than 75% of the license fee due within one year from shipment typically generates $120,000 in revenue in the quarter the product is delivered, but no future revenue. Additionally, revenue in a particular quarter may also be impacted by perpetual licenses in which less than 75% of the license fees and 100% of the maintenance fees are payable within one year from shipment as the related revenue will be recognized as revenue in the period when customer payments become due and payable.
Most of our customer arrangements are complex, involving hundreds of products and various license rights, and our customers bargain with us over many aspects of these arrangements. For example, they often demand a broader portfolio of solutions, support and services and seek more favorable terms such as expanded license usage, future purchase rights and other unique rights at an overall lower total cost. No single factor typically drives our customers’ buying decisions, and we compete on all fronts to serve customers in a highly competitive EDA market. Customers generally negotiate the total value of the arrangement rather than just unit pricing or volumes.
Total Revenue
 
July 31,
 
 
 
 
 
2017
 
2016
 
$ Change
 
% Change
 
(dollars in millions)
Three months ended
$
695.4

 
$
615.2

 
$
80.2

 
13
%
Nine months ended
$
2,028.2

 
$
1,788.8

 
$
239.4

 
13
%
Our revenue is subject to fluctuations, primarily due to customer requirements, including payment terms and the timing and value of contract renewals. For example, we experience variability in our revenue due to factors such as the timing of IP consulting projects, royalties, variability in hardware sales and certain contracts where revenue is recognized when customer installment payments are due. As revenue from hardware sales are recognized upfront, customer demand and timing requirements for such hardware may result in increased variability of our total revenue.
The increase in total revenue for the three and nine months ended July 31, 2017 compared to the same period in fiscal 2016 was primarily attributable to the overall growth in our business mainly due to higher hardware sales, IP consulting projects, TSL license revenue from arrangements booked in prior periods, and to a lesser extent due to revenue from acquired companies.

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Time-Based Products Revenue
 
July 31,
 
 
 
 
 
2017
 
2016
 
$ Change
 
% Change
 
(dollars in millions)
Three months ended
$
503.5

 
$
479.3

 
$
24.2

 
5
%
Percentage of total revenue
73
%
 
78
%
 

 

Nine months ended
$
1,494.0

 
$
1,427.7

 
$
66.3

 
5
%
Percentage of total revenue
74
%
 
80
%
 
 
 
 
The increase in time-based products revenue for the three and nine months ended July 31, 2017 compared to the same periods in fiscal 2016 was primarily attributable to an increase in TSL license revenue due to arrangements booked in prior periods.
Upfront Products Revenue
 
July 31,
 
 
 
 
 
2017
 
2016
 
$ Change
 
% Change
 
(dollars in millions)
Three months ended
$
100.3

 
$
66.9

 
$
33.4

 
50
%
Percentage of total revenue
14
%
 
11
%
 

 

Nine months ended
$
263.3

 
$
168.5

 
$
94.8

 
56
%
Percentage of total revenue
13
%
 
9
%
 

 

Changes in upfront products revenue are generally attributable to normal fluctuations in customer requirements, which can d